Equities continued to rally in July

The MSCI AC World index rose by 2.7% in US dollar terms in July, bringing its year-to-date performance to 13.2%. Emerging market equities (as reflected in the MSCI Emerging Markets index in USD terms) gained 5.5% over the month and are up 23.7% in the year to date. The progress made during the latest meeting of OPEC and non-OPEC oil producing countries regarding the oil output reduction agreement helped to boost oil prices in July, with WTI crude rising by 9.0% to USD 50 per barrel. This provided support for all emerging markets, in particular those in Latin America.

Exhibit 1: Emerging markets outperformed

Source: Bloomberg, BNP Paribas Asset Management, as of 30/07/2017

Positive environment and low volatility

Volatility fell once again on financial markets during the month, with the VIX, a measure of implied volatility (calculated on S&P 500 options) hitting a new low in July at less than 9.5%. On the whole, economic news flow was encouraging, supporting the view that the global economy is set to return to a GDP growth pace of 3.5% in 2017 and 2018, and microeconomic factors once again served as major sources of support of equities with the release of solid corporate earnings.

US markets ignored political developments in Washington

US equity markets outperformed by far, despite a confusing series of political developments. The US Senate at first rejected a bill that would have revoked Obamacare before settling on a partial revocation compromise in late July. This, among a series of other policy implementation failures, is beginning to undermine President Trump’s popularity. With tensions apparently escalating in the White House, he has made several major changes to his administration in recent weeks (Chief of Staff, the White House Communication Director and his successor) and has launched diatribes against the Attorney General in the aftermath of new developments in the investigation of possible Russian interference in the US election campaign.

Investors nonetheless shrugged all this off, encouraged by second-quarter corporate earnings that were solid, albeit less spectacular than in the first quarter. The S&P 500 gained 1.9% on the month; the Dow Jones 30, 2.5%; and the NASDAQ, 3.4%, driven by tech earnings, which far surpassed analyst forecasts on both the top and bottom lines.

Exhibit 3: Eurozone equities underperformed in July

Source: Bloomberg, BNP Paribas Asset Management, as of 30/07/2017

Eurozone equity indices were hit by the strengthening in the currency

Despite the ECB’s attempt to ‘spin’ Mario Draghi’s late June comments, which had triggered a run-up in the euro, the EUR/USD continued to rally in July. It ended the month slightly above 1.18, which was a high since early 2015 and marked a rise of 3.5% since the end of June and 11.9% on the year to date.

The EUR/USD rally picked up speed in mid-July from the 1.14-ish level that prevailed in late June to the level that had constituted the upper end of its trading range over the past two years. Once the euro broke through this resistance level, there was a significant increase in long euro vs. US dollar positions. This shift in investor positioning could heighten the bullish technical configuration. What’s more, market participants are pricing in a slightly weaker US economy and an ongoing improvement in the eurozone economy. In addition to this growth gap, which is favourable to the euro, there are expectations on future changes in monetary policy. Recent weeks’ events have pointed to a possible shift in ECB monetary policy, and this was enough to trigger a euro rally. In the US, doubts raised by the administration’s setbacks and, in particular, its inability to get healthcare reform past Congress, penalised the dollar.

Exhibit 4: The euro rose sharply – EUR/USD

Source: Bloomberg, BNP Paribas Asset Management, as of 30/07/2017

Although the economy continues to perform well and the ECB insisted that it would be “patient and cautious”, the EuroStoxx 50 rose only slightly (by 0.2%) after trading directionless in July. The CAC 40 fell by 0.5% and the DAX by 1.7%. The top-performing sectors were financials (banks and insurance companies) against a backdrop of a steepening in the yield curve. As usual, by the end of July there had been fewer earnings releases than in the US. European corporate earnings growth was far better than in the US but was driven mainly by the energy and finance sectors.

In Japan, the earnings reporting season turned out well, which kept the major indices relatively stable in July (the Nikkei 225 falling by just 0.5% and the Topix rising by 0.4%), even though the yen rose by 1.7% vs. the US dollar. The strong showing of sectors that are traditionally vulnerable to gains in the yen (sea transport, capital goods, iron and steelworks) shows just how confident investors are in the prospects for exports.

See you in Wyoming

The global equity rally in July ignored all the factors that, at other times, would have caused it to derail, including rather sudden shifts in developed economy currencies, political crises (or at least political uncertainties) in several emerging economies (such as Venezuela and Brazil), the outlook for less accommodative monetary policies in the US and Europe, and the Trump administration’s continuing difficulties in getting its programme through. Meanwhile, government bond yields remained low in absolute terms.

Against a backdrop of very low volatility of market indices and overvalued stocks, particularly in the US, there could be some kneejerk reactions if something were to upset Goldilocks. While monetary policy developments remain the focus of investors, the next major central bankers’ meeting, at the 24-26 August Jackson Hole symposium, could be crucial for financial markets.